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Tax Deduction Cap Idea Deserves Closer Scrutiny, Baucus Says

Cap could serve as part of the resolution for the looming fiscal cliff.

Capping tax breaks deserves a closer look as part of a resolution to the so-called fiscal cliff and an overhaul of the tax code, said Senate Finance Committee Chairman Max Baucus.

Similar-sounding ideas, such as a percentage limitation or a maximum dollar amount of deductions, can have disparate effects on taxpayers, the Montana Democrat said yesterday in an interview with Bloomberg News.

“It affects different groups differently and that all has to be better understood,” said Baucus, 70, whose committee has jurisdiction over taxes and entitlement programs. “In theory, you can do anything you want with numbers. I don’t mean to say that facetiously. I just mean it because it’s true. There are all kinds of permutations here, so long as it’s balanced, so long as upper-income Americans are more of the solution.”

Placing a cap on deductions and other tax breaks, floated by Republican presidential candidate Mitt Romney, could be a potential bridge between Democrats who want top earners to pay more and Republicans who want to avoid a tax rate increase.

Democrats have closed off some of the room left open earlier in the week for that compromise. Baucus and Treasury Secretary Timothy F. Geithner both said yesterday that tax rates on top earners must go up.

President Barack Obama will open talks with lawmakers by reiterating the plan from his fiscal 2013 budget, which called for $1.6 trillion in additional revenue from high-income taxpayers, White House spokesman Jay Carney said yesterday. That’s twice the amount that House Speaker John Boehner, an Ohio Republican, discussed in negotiations last year.

The fiscal cliff, a $607 billion combination of automatic spending cuts and tax increases, is scheduled to take effect in January. Many lawmakers, including Baucus, are both trying to avert the short-term fiscal austerity of the cliff and achieve longer-run deficit reduction.

“The math does not work without upper-income Americans contributing more than they have in the past,” Baucus said. “And second, it’s the right thing to do because otherwise the widening gap will become wider. And that’s not good for the country.”

If Congress doesn’t act, taxes on ordinary income, capital gains, dividends and estates will increase, pushing the top tax rate to 39.6 percent from 35 percent. Automatic spending cuts will take effect and the economy will probably go into a recession in the first half of 2013, according to the Congressional Budget Office.

Market Reaction

The CBO estimates that averting the cliff would protect 3.4 million jobs. The Internal Revenue Service warned yesterday that there would be “serious repercussions” for the 2013 tax filing season scheduled to start in January if Congress fails to address issues that affect 2012 tax returns.

Stock and bond markets have been reacting to the possibility that Congress may not reach an agreement on spending and taxes. Treasury yields show inflation expectations fell to a two-month low, as the difference between yields on 10-year notes and same-maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, narrowed to 2.40 percentage points yesterday, the narrowest gap since Sept. 13.

The Standard & Poor’s 500 index declined 5.5 points, or 0.4 percent, to close at 1374.53 yesterday in New York.

In an opinion article in today’s Wall Street Journal, Lloyd Blankfein, the chairman and chief executive officer of Goldman Sachs Group Inc., called on the Obama administration and the business community to come together in a “spirit of compromise and reconciliation.”

“There is more than a trillion dollars of cash that is sitting on the balance sheets of U.S. nonfinancial companies,” Blankfein wrote. “With certainty about tax rates, companies will increase their capital expenditures (currently at anemic levels), contributing to a virtuous cycle of jobs and growth.”

Also critical, he said, is restoring confidence in public finances through a program of spending cuts, entitlement reform and revenue increases. He said that tax increases for the wealthiest taxpayers are appropriate as long as they are accompanied by “serious cuts in discretionary spending and entitlements.”

Democrats, including Obama, want to extend only the tax breaks affecting income of individuals below $200,000 and married couples below $250,000. Republicans want to extend all of the tax cuts for a year and then overhaul the tax code.

Biggest Benefits

Compared with a rate increase, any limit on tax breaks would disproportionately affect people who use the biggest benefits in the code -- those for charitable contributions, employer-sponsored health insurance, state and local taxes and mortgage interest.

The state and local tax break, for example, benefits people who live in high-tax states such as New York, New Jersey and California, which traditionally vote Democratic. Those demographics make deduction caps politically difficult for the party.

Romney suggested a cap on deductions and credits that would be set at $17,000, $25,000 or $50,000. Martin Feldstein, an adviser to both Romney and President Ronald Reagan, has suggested capping deductions at 2 percent of adjusted gross income.

Obama, who will hold his first post-election news conference today, has proposed capping tax breaks so that taxpayers in higher brackets can claim them as if they were in the 28 percent bracket. That proposal, which first appeared in his budget in 2009, didn’t advance in Congress under either Democratic or Republican control.

Republican Senator John Thune of South Dakota said Geithner’s comments may signal “a very dangerous game” the administration would be playing if it demands a tax-rate hike “in a down economy.”

“There is a real risk” that higher taxes would “impede or hurt economic growth,” he said in an interview.

“Revenues are starting back up again” after declining “during the economic collapse” so “it would be a big mistake to now turn back and raise rates and put at risk and in jeopardy the economic recovery we hope is under way.”

An ultimatum for higher tax rates is risky at the start of negotiations because “they know that raising taxes is really a non-starter around here” for Republicans, said Thune, a member of the Finance Committee.

‘Thoughtful Fashion’

Representative Earl Blumenauer, an Oregon Democrat, said lawmakers should be open to the idea of caps and breaks, noting that it was one of the few specifics Romney offered.

“It’s important to be able to explore it in a thoughtful fashion,” he said.

In the interview, Baucus also said that he is still assessing whether the economy will need some short-term stimulus in 2013.

Part of the fiscal cliff is the expiration of a two-percentage-point cut in the payroll tax, and lawmakers have shown little enthusiasm for extending it.

“I want to see the numbers,” Baucus said. “Where’s the economy? Where’s Europe? Where’s China? What are economists saying?”

Baucus, who has been exploring ways to overhaul the tax code, said the resolving the fiscal cliff could include a “down payment” that would lead to work on the issue in 2013.

“A down payment might make good sense,” he said. “It probably does make good sense because tax reform is going to take longer than the time we have remaining this year. It’s going to have to be kicked over into next year.”

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